When Spain’s unemployment problem gets ugly

May 12 2010

When Spain’s unemployment problem gets ugly

Published by Andrew McCarthy at 11:54 pm under

With more than four million Spanish people out of work this week, the eighth largest economy in the world finds itself once more in a perilous position. In the last twelve months the number of unemployed people in Spain has doubled. Spain now has as many unemployed people as France and Italy combined, and the unemployment rate is nearing the historic highs of 1993.

The type of unemployment in an economy can be classified in different ways. The main types are cyclical or demand deficient unemployment but other forms exist such as real-wage unemployment and equilibrium unemployment. Some economists also refer to unemployed people as structural, frictional, seasonally or cyclically unemployed.

From the graph below we can see that unemployment in Spain has been high for at least the last 20 years, compared to other countries within the European Union.

Source: OECD Factbook 2009: Economic, Environmental and Social Statistics

The cause of growing Spanish unemployment in 2008 to 2010 is related to the collapse of the domestic building boom and the wider global recession. In 2006, Spain enjoyed low interest rates and therefore cheap loans, this allowed developers to build new apartment blocks, houses and commercial buildings with a relatively low cost of borrowing. Spanish people could afford mortgages at low interest rates and therefore purchased houses contributing to the building boom. However, when the flow of “cheap money” ran out in mid 2008 the building stopped and the flow on effects of spending dried up. Falling tourism receipts and less foreign investment have also exacerbated the issue leading to unemployment doubling between 2008 – 2010.

We can classify the form of unemployment, illustrated in the Spanish example as demand-deficient unemployment. It is related to a downturn in the economic cycle. This concept is explained below.

Effects and Solutions

The social and economic impacts of 20.7% unemployment are obvious, but the solutions are less so. Climbing unemployment creates two evils; falling tax revenue as workers no longer earn wages and the increased burden of paying benefits to the four million unemployed citizens. In addition, a series of social problems are often intertwined with high unemployment, these include depression; lose of skills, poverty and higher crime rates. Spain therefore has a few problems to solve this summer. Whilst Spanish people may enjoy a summer by the beach, and a glass of sangria, the government will be hitting the books to find a solution to the problem. Here are a few suggests to get the politicians thinking.

Use fiscal stimulus to boost consumer and government spending, thereby increasing the demand for jobs. Spain could plan for a budget deficit (expansionary fiscal policy) and fund spending increases though increased government borrowing. Spain’s current level of public debt is 67% of GDP, which is well below stricken Greece at 124%. However, Spain now has to borrow money from international bond markets, which are skeptical about Spain’s ability to pay back this debt. This is despite assurances and favourable rates offered from the European Union this week. Increasing government debt in a period of European financial crisis is a risky option.

Use loose monetary policy (lowering central bank interest rates) to encourage Spanish people to increase their consumer spending through increased borrowing. If you understand the complexities of the European Union, you understand that all 21-member countries use the same currency and follow the lead of one central bank. Despite one country wishing to lower interest rates, other countries may think differently. Europe can be compared to a train rolling along on a set of rails, with 21 separate carriages. Each European country must follow behind the big engine, there is no room to deviate from the central banks interest rates and all of the countries must move together. Many people have wondered how long the European train would run, before one of the carriages derailed.

Force Spanish firms to employ more people. Firms have no requirement to hire more people. They may choose to employ more people but will logically offer everyone lower wages to maintain profitability.

Use supply side policies to bring greater efficiencies to firms though increased on the job training and worker education. This is a long-term solution, which will require large structural adjustments, how Spain produces goods and services and exactly what is does produce. A startling statistic is that the average Spanish university graduate will find their first job at the age of 27, long after they have graduated.

Discussion Questions:

How do economists measure unemployment?
Explain how expansionary fiscal policy could reduce the rate of unemployment?
What does the concept of the natural rate of unemployment represent?
Evaluate the effectiveness and suitability of supply side policies to reduce unemployment in Spain

About the author: Andrew teaches IB Economics and IB Business Management at the International School of Singapore. He has previously taught in Wellington, New Zealand and graduated from Victoria University of Wellington.

5 responses so far

5 Responses to “When Spain’s unemployment problem gets ugly”

# Jacob Edwardson 14 May 2010 at 9:52 am

1. How do economists measure unemployment?
Unemployment is measured by doing: TLF (total labour force) – Employed population= Unemployed population.

2. Explain how expansionary fiscal policy could reduce the rate of unemployment?
Expansionary Fiscal policy is basically Government Spending (G). By increasing government spending, it will supposedly boost the Consumer Spending (C) because consumers will start spending money again. Which suggests that firms will get more money and then need to produce more because of the increased demand, and consequently employ more labour in order to produce enough. And the government may pay firms to employ more labour, which will decrease unemployment.

3. What does the concept of the natural rate of unemployment represent?
It represents the percentage of which unemployment will never go bellow. Because there will always be voluntary unemployment in the economy, which is natural. So the % of workers that are voluntary unemployed is the natural rate of unemployment.

4. Evaluate the effectiveness and suitability of supply side policies to reduce unemployment in Spain
The supply side policies aim to increase the potential GDP of the economy by increasing/improving the factors of production. And in this article it is mentioned that the Spanish population has experienced a loss of skills and increased crime rates, because of social factors. So the supply side policies may subsidize on education, which may lower these factors. And these policies will increase the use pf technology in firms, which will improve productivity.
Basically, supply side policies are the most effective type of intervention by the government because the demand side policies aren’t possibly applicable in Spain at this time. Because they can’t decrease taxation due to their high debt, so they can’t use fiscal policies. And they can’t lower interest because the central bank that controls the Spanish economy is the same in all Europe, and all countries must consent to the change, which right now, they won’t.
# Jakeb Stunzon 14 May 2010 at 10:51 am

1. Economist measure unemployment as a percentage of how many able workers there are in an economy that do not work… commonly both involuntarily and voluntarily unemployed.
2. Fiscal Policies as a demand side policy will help workers attain jobs in the short run by raising Aggregate Demand in the economy. Lowering taxes and increasing government spending will allow households to have more disposable income and firms to have more cash for workers while still being able to pay for costs of production.
3. and 4. are coming soon.
# Asuka Shirakion 16 May 2010 at 9:18 pm

1. Economists measure unemployment by calculating the unemployment rate, which is the percentage of the total labor force (total number of people employed or seeking employment in a country) that is unemployed but actively seeking employment and willing to work. This can be calculated with the formula – number of employed people divided by the total labor force.
2. Expansionary fiscal policy can help reduce the rate of unemployment, as increasing its spending with a budget deficit on infrastructure and building constructions will lead to an increase in demand for labor. Furthermore with more people having jobs, there will be more disposable income and so consumer spending will increase. This further leads to an increase in demand for goods and services, thus firms will employ more workers to meet the demand.
3. The concept of the natural rate of unemployment represents the rate of unemployment when the labor market is in equilibrium. Therefore it can also be known as the full employment level of unemployment. This involves the difference between those who would like a job at the current wage rate and those who are willing and able to take a job. Thus the concept includes; structural unemployment, frictional unemployment, and those who are not able to get a job because they don’t have the right skills.
4. Supply side policies are government interventions to improve productivity and efficiency in an economy. In Spain’s case, the lack of aggregate demand is reducing the demand for labor, therefore the country is going through demand deficient unemployment. Thus, demand-side policies are somewhat considered as more efficient. However, because of large debts and the central bank issue, supply side policies could be suitable. For example the development of technology can broaden the range of job opportunities, and so there is a higher chance that university graduates will get a job. Furthermore reducing income taxes for the small number of the employed Spanish population can attempt to increase disposable income and so increase demand for goods and services. Thus by also reducing corporation taxes, there will be an increase in the potential output of the economy, as a result stimulating the circular flow of income. However the results are likely to be more evident in the long term than in the short term.
# Youn Ho Junon 18 May 2010 at 9:33 am

1. The unemployment is calculated by unemployment rate. The unemployment is measured by employed people divided by the total labour force (employed + unemployed).
2. The expansionary fiscal policy can help boosting the aggregate demand curve. It will increase the consumer spending, therefore the firms earn more money and the demand for labour will increase to increase the productivity. The economy can grow further by more consumer spending as real wage increases and by multiplier effect.
3. The natural rate of unemployment is the level of voluntary unemployment people. The voluntary unemployment always present in the economy, and the unemployment level will never go below that level, so it is called natural rate of unemployment.
4. The supply side policy is government intervene to increase to aggregate supply of the economy. It is effective to increase the Real output of the country and at the same time, reduce the average price level. However, in Spain’s case, Spain is in deep recession. Followed by Neo-classical theory, the supply side policy is always effective even though economy is in recession because the Long Run Aggregate Supply will increase and the equilibrium will always shifts. However, followed by Keynesian theory, if we consider that the Spain is in deep recession, the supply side policy won’t be very effective to the economy.
# Eujin Jungon 18 May 2010 at 12:20 pm

How do economists measure unemployment?
-By calculating the unemployment rate, which is the percentage of the total labor force (total number of people employed or actively seeking employment in a country). Number of employed / total labor force.

Explain how expansionary fiscal policy could reduce the rate of unemployment?
-Expansionary fiscal policy could reduce the rate of unemployment. If the government increase its spending on infrastructure there will be increase in demand for labour. If more people unemployed, they have more disposable income to spend, which will lead to rise in spending.

What does the concept of the natural rate of unemployment represent?
-The natural rate of unemployment is the level of voluntary unemployment. The unemployment level will never go below that level.

Evaluate the effectiveness and suitability of supply side policies to reduce unemployment in Spain
-As Spain is in recession, the supply side policy is effective rather than demand side policy. LRAS will increase due to supply side policy.